Compliance as a Cost Driver

As the life settlement landscape keeps evolving, brokers and providers keep pace with regulatory growth.

While regulatory oversight of the secondary market for life insurance has expanded in recent years and brought a stabilizing effect, challenges to growth remain on both sides.

For regulators, financial reform at the federal level has raised expectations on consumer and investor protections, prompting consideration of a need for moreconsistent standards in the life settlement industry.

For life settlement providers and brokers, there is the added cost that comes with increased compliance, coupled with an ongoing need to breed familiarity with regulators and raise awareness among consumers.

Striking the proper balance between each objective may well determine the needed involvement of a third key player – those willing to bring investment capital into the segment.

“As the regulatory platform has really gotten its legs under it, I think the capital markets have become more confident that this is a well-regulated industry,” said Alan Buerger, chief executive of Coventry First LLC, a Philadelphia-area-based life settlement provider.

Buerger described regulatory inconsistencies across state lines as minimal and said disclosure requirements that now apply in some states to brokers and providers are very similar across boundaries.

While all but 12 states and the District of Columbia have yet to adopt life settlement regulations, Buerger noted that 85% of the nation’s population lives within areas that regulate life settlement transactions. He said the main areas of the law and disclosure requirements are largely consistent, but that states tend to do things in different ways.

“The real challenge is the expense of having to deal with regulators nationwide as opposed to a single regulator, or where there are common forms or common reporting,” Buerger said.

Market Shift

Buerger’s involvement in the life settlement industry dates back more than 10 years, when states made it onerous, if not impossible, for agents to get involved with the sale of life insurance policies by individuals to third parties.

He said the segment has now evolved into a handful of national life settlement brokers and a handful of regional ones. Consumers now have more options, and disclosure requirements on broker compensation in some states have added another dynamic.

“Because it’s now common to have compensation disclosure, the broker has to justify the added value that they provide,” Buerger said. “Many settlement brokers provide significant value because they know the market. They can shop and do a good job for the agent and the client, but many do not. Sorting that out is a difficult thing for agents and policy owners.”

Difficulty in discerning the added value was referenced in a July 2010 report that the U.S. Government Accountability Office conducted on the life settlement industry.

Forty-five states responded to a GAO survey that was incorporated into the study, which pegged the life settlement industry’s size at somewhere between $9 billion and $12 billion in 2008.

Twenty-two states require brokers to disclose compensation, and 21 require life settlement providers to disclose the compensation that brokers receive in a transaction.

According to information supplied by 25 providers, broker compensation as a percentage of the total amount paid to policy owners in life settlement transactions was 9% in 2009, down from 15% in 2006.

When it came to regulatory scrutiny, the survey results showed that 34 state regulators had the authority to conduct exams of licensed brokers and two dozen had done so in the past five years.

Similarly, only 22 of the 33 state regulators conducted exams of providers in the past five years.

Consumer Issues

Further defined in the GAO study are consumer-oriented challenges that policy owners may face in assessing whether life settlements are the best option, whether they are being offered a fair price and if they understand the risks that could manifest as tax issues.

A separate analysis by Conning Research & Consulting of the life settlement industry noted that the resources the industry used to help foster stabilizing regulations can now be channeled into building awareness. Among the fallout from those regulations are “increased barriers of entry for new providers and brokers.” Emerging areas of state regulatory concern also cited in the report included licensing fees and continuing education for industry professionals.

The settlement of annuities is part of a tax reporting issue that is also emerging. “Tax reporting on the sale of life policies requires obtaining information from the insurer, which in some cases has been difficult to obtain,” the Conning report stated.

Staying Focused

Buerger said his company now has eight or nine employees that are focused on compliance issues.

He can point to elements of his company’s own life settlement transaction process that were implemented more than a decade ago as part of an effort to build standards that were eventually adopted by a fledgling industry.

Every sale requires a preclosing interview with a policy owner and signed approval from the beneficiary, practices that Buerger said have become standard in the industry.

There are background checks on those who submit business, and the individual broker’s license is checked before each transaction.

For acquired policies with a face value of $250,000 or less, an attorney or certified public accountant must provide a letter stating the policy owner understands the transaction.

Interestingly, Buerger said he believes that people should hold onto their life insurance because it’s a valuable asset.

“But if they cannot afford to keep it, or their circumstances have changed, they can’t meet the premium requirements for whatever reason, then the option of the life settlement is a valuable option,” he said. “We want to make certain that that seller understands the transaction and what they are giving up.”

M. Bryan Freeman, president and managing member at Habersham Funding LLC, an Atlanta-based life settlement provider, said many consumers still aren’t aware that selling a life insurance policy to a third party can be a valuable alternative to letting it lapse or surrendering it back to the company.

A half-dozen states require insurers to inform consumers of the option before a policy lapses or is surrendered. Yet, Freeman said some captive agents are told by carriers that they can’t be a part of such discussions. It’s a practice that he said creates a real conflict.

“You don’t want a situation where it was in somebody’s best interest to do a settlement but you’ve told your agent they can’t even talk about it,” Freeman said. “If you look at any other financial instrument that’s being transacted with consumers, there are reams and reams of disclosures so that people know their options.”

Like others in the life settlement industry, Freeman welcomes a reasonable and effective level of regulation. His firm is among the 80% of licensed life settlement providers that belong to the Life Insurance Settlement Association, an advocacy group that has been instrumental in helping to pass laws at the state level.

Freeman said that while brokers and providers are obviously faced with more regulations, they can have a stabilizing effect. He said that in most domiciles, life insurance agents can easily transition into becoming registered life settlement brokers by filing a form and paying afee.

Freeman also touts Habersham Funding’s awareness and sensitivity to fraud. Ten employees at the provider have been certified as fraud examiners through the Association of Certified Fraud Examiners, and Freeman said he wants more to have that education.

Complex Due Diligence

While compliance issues are a cost driver, Freeman described the due diligence aspect as very laborintensive with transactions. The two aspects fuel the need to reconcile some 350 data points before a deal is resolved.

“We just don’t want policies that should not have been issued getting into our policy flow,” he said.

Brian T. Casey, a partner with Locke Lord Bissell & Liddell LLP, said compliance issues are generally expensive in the insurance industry, but especially so for the life settlement segment.

Casey said the garden-variety life settlement deal can take up to 60 days to close. The reasons are varied. Casey said some states provide a 30-day right of recission to policy owners who reach a life settlement deal. Multiple brokers representing a single policy owner can create confusion and yield competing offers.

Coverage needs to be verified with a life carrier, which he said can be a time-consuming process. There’s also the need to scrub the life settlement application for potential fraud, an aspect that could result in a transaction being legally challenged.

“Some would say that the life settlement industry is doing some of the work that the life carriers should have done in the first place,” Casey said.

Given his breadth of experience in the segment, Casey now conducts life settlement training sessions for attorneys.

“Even the small life settlement provider needs to have two or three lawyers on staff or they are going to be paying fees to firms” Casey said.

INDUSTRY PIONEER: Alan Buerger, chief executive of Coventry First LLC, said growth of the regulatory platform for life settlements has helped boost investor confidence.

Key Points

* The Situation: A GAO report on life settlements suggests that regulatory inconsistencies may pose challenges for consumers.

* The Background: Recent efforts at financial reform have placed a greater premium on consumer and investor protections.

* Watch For: As the life settlement industry grows, the regulatory scheme may follow suit.

Watch an interview with Alan Buerger at www.bestremw.com/ video. Digital readers: Hold cursor over icon for content.

Selling a life insurance policy to a third party can be a valuable alternative to letting it lapse or surrendering it back to the company

– M. Bryan Freeman, Habersham Funding LLC